I HOLD THIS TRUTH TO BE SELF-EVIDENT, THAT A DEBT CRISIS CANNOT BE RESOLVED WITH MORE DEBT

Friday, August 5, 2011

As The World Burns

Well, now it's official: The Debt Crisis is global. But what lies at the heart of it? What are the economic fundamentals which have created it?

In a word, "China". Oh, I don't mean that China as a nation is at fault, that it is to be blamed for the profligacy of Western consumers and their politicians' astonishing inability to lead, predict or - at least - to react properly. No, I use "China" as a label for our present borrow-spend-inflate assets economic paradigm

In the last couple of decades we in the West have moved a huge portion of our manufacturing to China and become junkies of debt-financed ultra-cheap goods. Said finance provided by China, of course. It doesn't take a PhD in economics to spot the imbalance, of course. As I have said many times before, the Debt Crisis is not the disease but a symptom, albeit a lethal one.

What is the proper remedy? Nothing less than a global shift in the economic paradigm: we urgently need to move away from global consumerism to local "investism" (to coin a word). Invest in what? you ask. Green energy, mass transport, environmental amelioration, recycling, responsible resource management - and these are just a few items that have the very real potential to create a boom in local manufacturing and skilled jobs for a very long time, measured in decades.

Think of it this way: what is more important for our own present and our kids' future? A third (and fourth and fifth) pair of cheap sneakers, or a new solar power plant? Another V8 4x4 monster, or a new electric railway? A fossil-fuel economy that resembles a roller-coaster nightmare, or an increasingly feasible electric utopia?

It's time to wake up from the bad dream and get to work building our very own Utopia.

PS For my European friends: Do you seriously think you can have a common monetary policy (the euro) without a common fiscal policy? Do you, really?

16 comments:

Do you seriously think you can have a common monetary policy (the Euro) without a common fiscal policy? Do you, really?

Of course I do. But we certainly do not mean the same thing when we talk currency.

Are talking use and abuse of seigneurage ?

Currency is only a medium of exchange it is as well a place where I can save my surpluses.

Not lose its purchasing power on a 2 to 5% percent annually. Just because it is liquid or supposed to be...

By the way there have a couple of countries following those rules in the past. Not unsuccessfully.

When a country is progressively getting short its very own currency with large bets against it, could one expect its academia to produce anything like robust monetary thinking? Or solid advice on such matters?

Well, that's precisely it. WHAT and WHOSE surpluses? The West is awash in debt and continuing deficits, whilst "China" is building dormant reserves letting them sit around as monstrous bond portfolios.

Otherwise, China needs to use its reserves and buy western goods and services on a MASSIVE scale, right now. And I don't mean iron ore and such, but honest-to-goodness high valued-added manufactured goods.

"Invest in what? you ask. Green energy, mass transport, environmental amelioration, recycling, responsible resource management - and these are just a few items that have the very real potential to create a boom in local manufacturing and skilled jobs for a very long time, measured in decades."

Sounds communist a few readers would say. This is why we are in such a toxic stew now, political divisiveness and extremist propaganda dominate.

The only thing we seem to agree on is what countries to bomb. Destruction not construction is the new American ethos and destruction is what we will reap me thinks.

Amen. Well said, problem is, it's easier said than done. Unfortunately for the solution to be implemented, men must put their selfish ways aside. Is this possible at all on the required global/regional scale to be a viable solution? Human nature at play here.

When the Europeans set up monetary union 12 years ago, everyone understood that there was no fiscal safety net.

Therefore, the Europeans put in place a series of fiscal rules that should have prevented a profligate country from destabilising the single currency.

The Maastricht criteria governed the entrance requirements. The stability and growth pact determine the rules for member states. Everyone was supposed to keep their debt under 60% of GDP. No one was supposed to have a deficit greater than 3%.

These were good rules. They were well designed and the reflected the needs of monetary union that wouldn't have a central fiscal authority.

However, the Europeans broke those rules. First, Italy and Belgium were allowed to enter despite the fact they had not met the entrance requirements. Then Greece was allowed to join.

Later, in 2003, Germany and France failed to keep to the rules outlined under the stability and growth pact.

Since the Europeans didn't abide by the rules, they put the single currency to the test. Now they are finding out in the most horrible way imaginable that those rules mattered.

I don't say that it serves them right. On the other hand, things will be so much better if they kept fiscal policy under control in the years prior to 2007.

"Currency is only a medium of exchange it is as well a place where I can save my surpluses."

Sorry, but you can't save your surplus in a medium of exchange. Well, not unless your time frame is quite short, but then that's not saving. This condition gets to the greatest failing of the dollar, which is that it sought to be both a medium of exchange, and a wealth storage mechanism. A reserve currency is, by definition, an oxymoron.

We are going to see the dollar fail as both a medium of exchange and a wealth storage mechanism in due course, and the latter failure will be a permanent one.

Having said that much about the dollar, the architecture of The Euro is fundamentally different from that of the dollar. The treatment of physical gold-the time honored, dare I say "traditional" (thanks, Ben Bernanke) mechanism in which to store one's surplus-is at the heart of what make's the Euro different from the dollar and this facet, among others, is likely what will allow it to make it through the present period intact. The Euro, as per the vast majority of commentary on it, is a very misunderstood currency as some of its greatest strengths are, mistakenly, cast as weaknesses.

You focus on trade imbalances between nations as I have often. After all, every surplus is matched by a deficit. But this is also true between any two trading entities - between rich and poor for instance and the big one, between workers competing for assets with their very own pools of wealth...funded pension pots.

Yes, an even bigger issue than China/Japan/Germany is the search for yield by an ageing workforce that has pushed assets to huge heights - property and shares, such that the yields have collapsed and require even more feeding and imbalances...the snake is eating its tail.

China will not buy anything from the West - it is obvious every time that one does business inside China that the Chinese *never* voluntarily leave anything on the table for the competition!

China will instead attempt to buy raw materials, land, influence, companies e.t.c. The recent "liberations" in the middle east is exactly about US/West doing some spoiling and griefing to ruin the Chinese and Russian investments in the area.

The final, logical, step is to directly stiff the Chinese et.al. and default; probably by printing because QE looks nicer than the straight default.

Gold bug die-hard! The outcome sought by exchanging and surplusing is to be consistantly secure (food, clean water, etc). Exchanging the surplus now in the form of sustainable infrastructure is the more logical way of achieving the desired outcome.

You know, way back when, when Descartes decided that the "new science" was just what we needed to get back to the garden, and in control of it, this time, he set up the ideological framework in which the consumer society plays out : unlimited despoilment of nature's resources, world without end, amen. Man in the driver's seat.The paradigm for unlimited, and OBLIGATORY constant growth goes at least back to Descartes, if not before. Growth along with total control of human and natural activity for large scale transformation of our natural world.This is just not possible.And to make things more complicated, "we" have suddenly realized (many, many of us) just how impossible this is AND ALWAYS WILL BE. We are no longer GOOD BELIEVERS in the consumer society.And many of us are also starting to wake up to the realization of how much this Enlightenment paradigm all holds together : economically, but also POLITICALLY.(Everything is political, anyway...)Trying to make believe that it IS possible... well, I think that just sinks us deeper into... DEBT? Certainly it undermines our FAITH in our symbolic systems, and their capacity to assume economic exchange, while BEING WORTH SOMETHING...in OUR eyes, and in the eyes of others. As far as China buying our manufacturing goods... WHAT'S TO BUY, when we basically are having a very hard time BELIEVING IN MANUFACTURING TOO THESE DAYS AS A MEANS OF ORGANIZING WORK ??I mean, as a society, of course...As I have said before, this crisis is also a BIG crisis of the nation state as an IDEAL, and as a means of creating a structure to FEDERATE human beings around a common cause/identity.The Chinese HISTORICALLY do NOT exchange outside of their culture. Why should they change millenia long cultural practices RIGHT NOW ?That goes against that most famous social force : inertia as a means of fixing identity, and insuring continuity. Let's PRAY that the Chineses manage to resist the forces that are busy SUCKING US UNDER...Unless we axe the Enlightenment paradigm, that is...What choice do we have ? Axe it... or get axed BY it...This may sound rather extreme to certain people, and it is, I admit. I hope I'm wrong about this one..

A Bavarian friend asks:How long do you give Europe WITH a common fiscal policy (Eurobonds)? If it were only a few years before moral hazard, human weaknesses and bad demography blow the currency system apart anyway - would it then be a good idea to ruin a relatively functional country (Germany), just for the sake of trying to be a good European this time?No nationalism here, more provincialism.Personally, I am even against ruining a functional "Free State" for the sake of a progressively disfunctional Germany. Real functioning Democracy cannot be preserved in big agglomerated entities like the EU or even Germany .....

John Maynard Keynes had many interesting thoughts and ideas and they changed throughout his life. I also know he is much maligned having being misattributed for recommending 'stimulus spending'...however note he thought the state should never exceed 20% of gdp, but that part is by-the-by.

One of his ideas was the 'bancor' and international currency regime that would cause surplus countries to have to keep adjusting their currency upwards by agreement until bilateral trade balanced. This was vetoed by America who after the Second World War was the only country standing and saw this as protectionism by the weak British Empire.

But the other bit I wanted to mention was his final conclusion that we should all strive for 'national self sufficiency' having been advocate of untrammelled free trade all his life. He saw this as the route to avoiding global wars and was a death bed conversion of sorts.

http://www.mtholyoke.edu/acad/intrel/interwar/keynes.htm

"I was brought up, like most Englishmen, to respect free trade not only as an economic doctrine which a rational and instructed person could not doubt, but almost as a part of the moral law. I regarded ordinary departures from it as being at the same time an imbecility and an outrage. I thought England's unshakable free trade convictions, maintained for nearly a hundred years, to be both the explanation before man and the justification before Heaven of her economic supremacy.

....

But I am not persuaded that the economic advantages of the international division of labor to-day are at all comparable with what they were. I must not be understood to carry my argument beyond a certain point. A considerable degree of international specialization is necessary in a rational world in all cases where it is dictated by wide differences of climate, natural resources, native aptitudes, level of culture and density of population. But over an increasingly wide range of industrial products, and perhaps of agricultural products also, I have become doubtful whether the economic loss of national self-sufficiency is great enough to outweigh the other advantages of gradually bringing the product and the consumer within the ambit of the same national, economic, and financial organization. Experience accumulates to prove that most modem processes of mass production can be performed in most countries and climates with almost equal efficiency. Moreover, with greater wealth, both primary and manufactured products play a smaller relative part in the national economy compared with houses, personal services, and local amenities, which are not equally available for international exchange; with the result that a moderate increase in the real cost of primary and manufactured products consequent on greater national self-sufficiency may cease to be of serious consequence when weighed in the balance against advantages of a different kind. National self-sufficiency, in short, though it costs something, may be becoming a luxury which we can afford, if we happen to want it."

About Me

I was educated as a chemical engineer but spent almost my entire career in finance, particularly in money, FX and bond markets. The name stands for Hell-as-IOUs and the picture points to Quixotic endeavors.